Ron Aucutt's 'Top Ten' Estate Planning And Estate Tax Developments Of 2012

As 2012 comes to an end, "Uncertainty" is certainly the operative word for tax professionals. No one knows (as of this date) what the tax laws, including the estate, gift, and generation-skipping tax provisions, will be in 2013. The possible return to the tax laws as they existed before the 2001 Tax Act encouraged many to take advantage of the favorable laws in 2012 to give away large amounts of property. In the midst of the often hurried planning caused by the unclear tax landscape, the usual types of developments continued to occur. Courts issued opinions and the IRS continued to issue public and private rulings that affected many different areas. Taking account of the numerous developments with respect to estate planning and estate, gift, generation-skipping, and fiduciary income taxation in 2012 and in what has become an annual tradition, below are the top ten developments as identified and explained by Ronald Aucutt, a McGuireWoods Partner and Leader of the firm's Private Wealth Services Group. Ron is the editor of the Recent Developments materials that are presented each year at the Heckerling Institute on Estate Planning, and no one is in a better position to review and opine on what are the top ten developments in estate planning and estate, gift, and generation-skipping taxation for 2012.

Number Ten: FLP Cases Still Driven by Facts – Mostly: Estate of Kelly v. Commissioner, T.C. Memo 2012-73

As long as the outcome of family limited partnership cases continues to be fact-specific, expert-specific, and sometimes even judge-specific, an FLP case is likely to be one of the ten most watched or most discussed developments of the year. In Estate of Kelly, for example, the Tax Court rejected an IRS challenge to a family limited partnership under section 2036, in one of the few cases to ever do so without invoking the "bona fide sale" exception, but on facts that would be difficult to duplicate.

"Bad" facts (for the estate) included the creation of the partnership by the creator-decedent's children acting as her court-appointed guardians (arguably negating the notion that the partnership was needed for management), a purpose of ensuring an equal distribution of the decedent's estate among her four children at her death (arguably a testamentary purpose), and the decedent's retention of sole ownership of the corporate general partner, which was expected to receive a management fee (arguably an impermissible retained interest). In fact, in seeking court authority to implement the plan, the children represented that this arrangement would "ensure that the ward will be provided with adequate income to cover the ward's probable expenses for support, care and maintenance for the remainder of the ward's lifetime."

This latter fact has been crucial in other FLP cases, where the IRS and the courts have viewed insufficient retained assets outside of the partnership as evidence, in effect, that the parties treated the partnership as a trust, with retained enjoyment. It is with good reason, however, that that argument is often regarded as overstatement. If the standard for comparison is an arm's-length "investment," then why isn't it relevant that such arm's-length investments are frequently (if not typically) made with the expectation that the investment will produce a return and that the investor might live off that return?

On the other hand, "good" facts for the Kelly estate included the astonishingly self-evident legitimacy of the asset-protection and risk-management purposes of the partnership, evidenced by dynamite blasting at quarries on the partnership property, an incident of a dump truck collision over which the decedent had been sued, and the discovery of bullets in a campfire site on the property. Like the similar 2012 case of Estate of Stone v. Commissioner, T.C. Memo 2012-48 (formation of partnership to manage and develop woodland parcels), this was not a garden-variety FLP holding marketable securities. It is hard to tell why the IRS permitted it to be litigated in the first place.

In contrast, in Keller v. United States, 697 F.3d 238 (5th Cir. 2012), aff'g 104 A.F.T.R. 2d 2009-6015 (S.D. Tex. 2009), the facts did not seem to matter at all. Keller is a case in the tradition of Church v. United States, 268 F.3d 1063 (5th Cir. 2001), respecting a family limited partnership even though the formation and funding of the partnership were not completed until after the decedent died. To be sure, the case did present compelling evidence of pre-death "intent," and the Service's case was apparently weakened by actions of its appraiser that the courts viewed as mistakes. But the notion that, in the administration of the estate tax, death does not matter is truly interesting.

Number Nine: Regulation on Partial Special Use Valuation Election Held Invalid Again: Finfrock v. United States, 109 A.F.T.R. 2d 2012-1439 (C.D. Ill. 2012)

Section 2032A allows an executor to value "qualified real property" at its current "qualified use" in farming or another trade or business, rather than its "highest and best use." "Qualified real property" is defined in section 2032A(b)(1) with reference to the requirements that

50 percent or more of the adjusted value of the gross estate consists of the adjusted value of any property used in a qualified use that passes to a qualified member of the decedent's family (section 2032A(b)(1)(A)); 25 percent or more of the adjusted value of the gross estate consists of the adjusted value of such property that is real property (section 2032A(b)(1)(B)); and Such real property was owned and used by, and with material participation of, members of the decedent's family during five years out of the eight-year period ending on the decedent's death (section 2032A(b)(1)((C)). Reg. §20.2032A-8(a)(2) (emphasis added) states that "[a]n election under section 2032A need not include all real property included in an estate which is eligible for special use valuation, but sufficient property [that is, 25 percent] to satisfy the threshold requirements of section 2032A(b)(1)(B) must be specially valued under the election ." In Miller v. United States, 680 F. Supp. 1269 (C.D. Ill. 1988), involving a decedent who died in 1983, a judge in the Central District of Illinois had held that the requirement that the special use election be made for real property representing at least 25 percent of the adjusted value of the gross estate was invalid, because there is no such requirement in the statute. The Miller court had held that Reg. §20.2032A-8(a)(2) is an "interpretive" regulation, entitled to less deference than a "legislative" regulation promulgated under a specific grant of rulemaking authority, noting that section 2032A(d)(1) specifically authorizes regulations regarding only the "manner" for making a special use election, and this regulation purports to add a substantive requirement.

In Finfrock, the IRS argued that the result should be different under the deference standard of Chevron v. Natural Resources Defense Council, 467 U.S. 837, 843 (1984), that if "the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute," a standard the Miller court had not applied. The court rejected that argument, finding that the statute is "neither silent nor ambiguous" in setting forth the requirements for a special use election, which do not include the requirement that, once eligible, an estate must elect special use valuation for real property representing at least 25 percent of the adjusted value of the gross estate. Therefore the court did not reach the issue of whether the regulation would be "a permissible construction of the statute" (which the executor had conceded) and, like the Miller court before it, held the regulation invalid.

It remains to be seen how durable the Finfrock holding is, or if the regulation will be tested outside of the Central District of Illinois. But it is always interesting when any court holds a Treasury regulation invalid.

Number Eight: Continued Crackdown on Questionable or Careless Donations of Historic Façade and Other Conservation Easements

No less than 16 cases in 2012 have addressed the availability and amount of an income tax deduction for a donation of an historic façade or other conservation easement. Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012), vac'g and rem'g 134 T.C. 182 (2010), reh'g 136 T.C. 294 (2011); Scheidelman v. Commissioner, 682 F.3d 189 (2d Cir. 2012), vac'g & rem'g T.C. Memo 2010-151; Trout Ranch LLC v. Commissioner, 110 A.F.T.R. 2d 2012-5621 (10th Cir. Aug. 16, 2012), aff'g T.C. Memo...